I’m in my 20’s, and grew up in Dublin, Ireland. And yikes, it’s difficult to buy a home.
Housing truly is one of the backbones of society. One’s home is integral to one’s life, to state the obvious. Tune into any election debate, any public discourse, attend any dinner party – the topic of housing is bound to come up.
In big cities, the story is familiar. Too much demand, too little supply, and sky-high prices. Looking at the UK specifically, the below chart sums it up well – house price relative to incomes have skyrocketed, making it increasingly unaffordable to purchase a home.
There is now talk of housing prices pulling back, with all sorts of predictions around the potential declines we could see. While I have written about why I don’t believe most doomsday predictions are accurate (most notably in this piece last November) there is no doubt that the market has softened from the days of the dizzying pandemic bull market, when prices spiked at unprecedented speed.
But the question is then, what happens if house prices fall?
It is tempting to conclude that this would be a good thing, especially in looking at the above chart on spiking affordability. And sure, given my age and desire to soon purchase a home (a kid can dream, right?), it would be nice to live in a world where the average home price isn’t in a different stratosphere than my income. But the question is a bit more nuanced.
Homeowners don’t diversify
What makes housing so intriguing is that, in one respect, buying one violates the cardinal rule of investing: diversification and portfolio management, things I have written about plenty.
It violates these rules because houses are such expensive assets that they often represent the bulk of one’s wealth. Indeed, this has been the older generations’ manual for accumulating wealth: work when you’re young, buy your home, continue to work to pay off the mortgage. And then sit on that house and watch it appreciate. Your home is your pension.
It is no coincidence that we are seeing the rise of populist politics, iconoclastic projects like cryptocurrency, and a general feeling of division and unhappiness. Millennials and Gen Z’ers are realising that, for the first time in many generations, they will not be richer than their parents. It’s something of a generational war.
And a lot of this comes down to housing.
Of course, there is one way the millennials get rich: inheritance. This makes things even worse because inequality in society continues to mushroom (something which COVID exacerbated). The most important decision we ever make is deciding what family we are born into, after all. Make the right call there, and these housing prices will be OK in the end.
As the excellent (Irish!) economist David McWilliams said on a recent podcast, it creates an inheritocracy.
House prices dropping pulls down the economy
But despite all this tempting me to pick up my pitchfork and cheer incessantly for a nasty housing crash, that would be to miss the bigger picture.
When house prices crater rapidly, a negative wealth effect takes hold. This is because of what we discussed earlier – a person’s house is their main asset and therefore main source of wealth. Therefore significantly lower wealth leads to consumption drying up, all leading to the dirtiest word in economics: recession.
Fall fast enough, and you can even find negative equity. This is when the value of a home becomes less than what a consumer owes on the mortgage. As an Irish person, I know what this means well – we saw 31% of mortgages in negative equity by the end of 2010. Ouch.
This tanks the economy, simply put. Obviously, 2008 was an extreme example, what with banks going under as defaults flowed left, right and centre on mortgages. Banks are far better capitalised these days, and in a much healthier position overall.
But falling prices discourage borrowing, lending and consumption in the economy. It suffocates activity and is not a good thing for anybody. So while it may be tempting to sit around and plea for a housing crash, be careful what you wish for.
*Sigh*. Back to work I guess, there is rent to pay.
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